Joanna Nash, portfolio manager for Acadian Asset Management, warns investors about falling into a yield trap, which happens when a very high dividend attracts investors to a potentially troubled company.

“Due to the large fall in stock prices, many stocks have a very attractive historical yield, which will not necessarily be reflected in the second half of the year,” says Nash. High yield can signal good value but may also be a sign of distress.

Dividends, which are the income component of shareholder returns, accounted for more than 50 per cent of the returns from investing in Australian stocks over the past decade, according to Morningstar, which monitors financial products.

Rock-bottom interest rates on savings mean that fully-franked dividends are an increasingly important source of investment income, particularly for retirees with self-managed superannuation funds.

We are favouring investing in essential services, supermarkets, infrastructure packaging and hospitals and aged care.

— Dermot Ryan, AMP Capital

“Revenues in Australia’s locked-down economy are temporarily drying up and working capital is becoming an issue even for the companies with low levels of debt,” says Ryan.

For example, hearing device company Cochlear has announced it is tapping investors for $800 million to strengthen its balance sheet, the first time it has gone to shareholders for fresh funds in 25 years.

“It is only reasonable that dividends are crimped to preserve cash too, particularly as debt costs for non-investment grade companies spike.”

Qantas Airways has deferred its $201 million interim dividend from April 9 until September and has temporarily stood down 20,000 workers.

Northern Star Resources, a gold production and exploration company, was due to pay a 7.5¢ dividend, about $55 million in total, on March 30 but pushed that back by at least seven months.

Macquarie Group has reduced 2019-20 dividend forecasts for 73 of 182 Australian stocks it researches.

Pockets of real value

“This trend is likely to continue as companies report their full-year results and we see the impact on earnings over the next couple of months,” says Nash.

Ryan adds that this crisis favours long-term investors and that there are pockets of real value in the market. He recommends “calmly looking through the short-term pause to find companies that can grow their dividends in normal times”.

The majority of dividends announced in February have been paid, as the accompanying chart shows.

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Banks and real estate investment trusts (REITs) are the main sectors remaining to pay large dividends before the end of the financial year.

“Both sectors are likely to cut dividends sharply in quarter two as the knock-on effect of rent and mortgage abatements means less cash, and they will need to keep capital to service their own debts as these sectors carry high debt loads,” says Ryan.

REITs, traditionally seen as a defensive sector in the equities market, are seen as vulnerable because of their high exposure to the struggling retail sector, triggering heavy selling.

“The virus outbreak and lockdown have dramatically slowed economic activity, particularly in travel and aviation,” says Ryan. “We can now see that the consumer impact has spread to retail, media and gaming. These sectors are unlikely to pay any more dividends this year.”

Investors are being encouraged to diversify the source of dividends and avoid a yield trap by seeking companies with strong balance sheets and cash flows.

“We also expect telecommunications and service providers to do well as households increase their mobile and broadband packages and carriers start tier 5G capex spending,” he says.

Nash adds: “In the medium term, some of the more defensive sectors such as utilities and consumer staples (which includes food, beverage and household goods) may provide more certainty in the yields that they will deliver. The banks are also likely to provide a good yield although maybe not at the levels they are currently showing."

A weak Aussie dollar should also boost the performance of export stocks, such as energy, mining and, as consumer sentiment begins to improve, wine.

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